Greek election will bring a new crisis

Commentary: Splintered government may not be able to deliver

By

BarryWood

WASHINGTON: Greek voters choose a new parliament Sunday and the results are unlikely to promote either stability or reform. Four years into a severe economic crisis, Greeks have soured on the leftist PASOK and center-right New Democracy parties that have been in charge for 40 years.

With the economy in free fall, Greek politics appear to be fracturing with polls suggesting that eight to 10 parties — from the extreme right to extreme left — will enter the 300-seat Parliament.

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PASOK and New Democracy, say analysts, may not be strong enough to form a left-right coalition of the kind in place for the past few months. A new government is almost certain to be weak, calling into question its capacity to implement the tough reforms required by the $170 billion international rescue program approved just two months ago.

Desmond Lachman, a former International Monetary Fund economist who follows the Greek economy at the American Enterprise Institute, calls the last two months the calm before the storm. While even more worried by Spain, Lachman fears the Greeks have no way out from the depression that has dragged gross domestic product down by 14% in four years. The IMF, whose $37 billion Greek loan is its largest ever, expects economic activity to fall nearly 5% this year with a turnaround possible next year. Unemployment is 18% and rising with youth unemployment at 40%.

Lachman calls the austerity policies advocated by the IMF and European Union “insane,” exactly the wrong thing to be doing, since slower economic activity widens the budget deficits that austerity was intended to narrow.

The government emerging from the election faces a June deadline for winning parliamentary approval of $14 billion of further deficit reduction. Spending cuts equal to 5.5% of GDP are mandated under terms of the March bailout agreement. Proposed cuts in defense and health spending will add to the economic pain that already has meant cuts of up to 25% in wages and pensions.

Athens economist Miranda Xafa says that despite the pain Greece needs to persist with the austerity medicine. A Greek representative to the IMF in the 1990s, Xafa blames the two big parties for the over-spending and bloated government that she believes created the crisis. Xafa says “real income and wealth will fall sharply in any case, regardless of whether Greece exits the euro zone or not.” Rejecting suggestions that going back to the drachma would assist recovery, she says Greece’s choice is between negative growth with the inflation that would result from a currency devaluation or negative growth without inflation.

Creditors agree that only deep structural reforms can restore Greek competitiveness. In the decade before the crisis exploded in 2010 government spending soared and nothing was done to boost tax collection or promote entrepreneurship. Greece lived far beyond its means.

An IMF study determined that over the past decade unit labor costs rose 35% in Greece, far more than in other euro-zone nations. Greece’s minimum wage was 50% higher than in Portugal and 18% higher than in Spain. IMF economist Mark Flanagan concedes that even if the structural reforms go forward it will be the end of the decade before Greece regains lost competitiveness.

As part of this year’s bailout, private-sector creditors have written off 70%, or $142 billion, of Greek debt. The bailout rescued Greece from insolvency and both the IMF and the European Union agreed to backstop Greece’s borrowing needs, provided Athens implements austerity measures to close a huge fiscal deficit. That commitment is now on the line.

Lachman of AEI doubts whether the Greeks can implement the promised reforms. Charles Dallara of the Institute of International Finance, who negotiated the private-sector write-down or default, says they can. “They will continue the reforms,” he says, “because they’ve already invested so much in them.” Dallara believes the write-down creates a huge opportunity for Greece to get its finances right. Xafa, from the perspective of living in Athens, is cautious. “I’m doubtful,” she says, “that the two main parties can lead us out of the crisis.”

The answer won’t be long in coming as the troika, creditor representatives from the IMF, EU and European Central Bank, will soon assess Greece’s progress in making good on promised reforms.

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